The use of bitcoin as collateral could enable the creation of new financial instruments and open opportunities for institutional players.
Over the years, bitcoin has been leaving behind its reputation as a high-risk investment and is increasingly recognized, even by companies and states, as a new form of store of value. This transformation has paved the way for a convergence between traditional finance and bitcoin.
One example is the emergence of loans with bitcoin as collateral, which allow users to obtain liquidity without the need to sell their assets.
How it works
The mechanism requires borrowers to deposit bitcoin as collateral to obtain a loan, typically disbursed in fiat currency or stablecoins. Usually, the procedure involves transferring bitcoin to a platform’s wallet, with the loan amount determined based on the collateral value. At the loan’s maturity, the user repays the principal plus interest and recovers the collateral.
Below are some fundamental concepts for understanding the functioning of loans:
- Collateralization: the act of pledging bitcoin as collateral, with the loan amount representing only a fraction of the value of the locked collateral;
- Loan-to-Value (LTV) ratio: the ratio between the loan amount and the value of the bitcoin collateral, which determines the maximum amount that can be borrowed and triggers margin calls. LTV ratios typically vary from 40% to 70%, depending on the platform and perceived risk. Some platforms offer higher LTVs, but this could involve higher interest rates or more restrictive margin call policies;
- APR (Annual Percentage Rate): APR is a way to understand the total cost of a loan in a year. It includes not only the interest but also any other expenses associated with the loan;
- Margin requirements and Margin call: the need for borrowers to maintain a certain LTV; if the value of the locked bitcoin decreases, lenders can issue margin calls, requiring borrowers to add additional collateral or repay part of the loan to avoid liquidation. Margin call thresholds vary among platforms. Some platforms use proprietary technologies to monitor the collateralization value in real-time and automate liquidations. The specific triggers and resolution periods for margin calls are aspects that borrowers must understand to effectively manage risk;
- Liquidation process: if the borrower fails to meet margin calls, the platform can liquidate the bitcoin collateral to recover the outstanding loan amount. Liquidation can occur automatically if the LTV reaches a critical level. Platforms may charge processing fees for liquidations.
Custodial vs. non-custodial
Bitcoin lending platforms are primarily distinguished by how they manage users’ private keys. Custodial platforms require users to deposit their bitcoin, with the platform holding the private keys, similar to the operation of an exchange or a traditional bank. Similar examples include centralized services like Nexo and Ledn. In contrast, non-custodial platforms allow users to partially maintain control of their private keys through a multi-sig wallet. In both custody models, users generally must complete identification procedures (KYC) by providing identity documents, social security numbers, and residential addresses.
Platform overview
The following table summarizes the main Bitcoin lending platforms:
| Platform Name | Model | Supported Collateral | Loan Currencies | Interest Rates (Approx.) | Key Features | Target Audience |
|---|---|---|---|---|---|---|
| Nexo | Custodial | BTC and other digital assets | Fiat, stablecoin | 2.9% – 18.9% APR | Immediate approval, no credit score check, high loan limits for upper tiers | Retail, High Net Worth |
| Ledn | Custodial | BTC, ETH | USD, USDC | ~12.4% | Proof-of-Reserves, transparent, focused on BTC & ETH | Retail, institutional |
| Bitfinex Borrow | Collaborative custody and p2p | BTC and other digital assets | USDT | ~16.9% | LTV up to 80%, flexible terms, no credit score check, multi-sig custody | Retail, institutional (excluding some jurisdictions) |
| Unchained Capital | Collaborative custody (2-of-3) | BTC | USD | ~14% | Institutional focus, collaborative custody (user holds one key), no rehypothecation | Institutional, minimum $10,000 |
| Hodl Hodl | Non-custodial and p2p | BTC, L-BTC | Stablecoin (USDT, USDC), Fiat (USD, EUR) | Varies | P2P, non-custodial, multisig escrow, users set terms | Retail, institutional |
| Debifi | Non-custodial (3-of-4) and p2p | BTC | Stablecoin (USDT (no-KYC), USDC), Fiat (USD, EUR, CHF) | ~10% – 15% APR | P2P, non-custodial, 3-of-4 multisig, overcollateralized, institutional focus | Institutional, bitcoiner |
| Firefish | Non-custodial and p2p | BTC | USDC, EUR, CZK | ~7% – 13% APR | P2P marketplace, multisig escrow, no rehypothecation, emergency recovery | Bitcoiner, institutions |
| Lava | Non-custodial and p2p | BTC | USD | From 5% APR | Non-custodial, trustless smart contract, KYC-free (mainly USA) | Retail, institutional (USA) |
New opportunities for institutionals
Institutional investors can derive several advantages from bitcoin-backed loans. Liquidity management is the primary opportunity, as institutions holding bitcoin as part of their treasury reserves can access immediate liquidity without disrupting their long-term investment strategies. Companies with bitcoin reserves can use them as collateral to obtain operational liquidity without having to sell their assets, thus maintaining exposure to potential long-term appreciation.
The high yields offered on some of the platforms mentioned can also attract companies looking for improved returns (but, it must be said, also deter those seeking a loan). Financial institutions could participate in the market as liquidity providers, obtaining interesting returns with risk mitigated by the presence of bitcoin collateral and gradually lowering the market interest. According to Bloomberg, already in 2022, the investment bank Goldman Sachs granted its first loan with bitcoin used as collateral.
“Never sell, collateralize”
In the book “The Ultimate Collateral,” written by Martin Connor and published by Braiins, the concept of “never sell, collateralize” is explored. The strategy is based on the idea that, given Bitcoin’s nature as an asset with long-term appreciation potential, it is more advantageous to use it as collateral to obtain liquidity rather than sell it. Companies like Braiins have already successfully adopted this approach to finance growth while maintaining their bitcoin reserves. The Czech company recently used Firefish to obtain a $400,000 loan, using their bitcoin as collateral to expand business operations. The CEO of Braiins Eli Nagar stated:
“We believe that the ability to use one’s bitcoin as leverage – without selling it – will be a fundamental tool in the future.”
The book emphasizes how collateralization is a widely adopted practice in traditional finance but highlights the lack of native options for bitcoin until a few years ago. The CEO of Firefish Martin Matejka commented:
“Collateralization is widely used in traditional finance. A piece was missing: Bitcoin. Our goal was to ensure that you never had to sell your bitcoin – that you could live off it.”
Taxation and tax advantages
In the United States, obtaining a bitcoin-backed loan is not considered a taxable event. Selling bitcoin, on the other hand, triggers capital gains tax, with rates depending on the holding period (short or long-term) and income level. Interest paid on bitcoin-backed loans could be deductible, particularly if the borrowed funds are used for investment purposes. However, collateral liquidation is generally considered a taxable event.
In the European Union, the tax treatment of bitcoin-backed loans may vary depending on the member state and is still evolving. The sale of bitcoin is generally subject to capital gains tax or income tax depending on the country and the nature of the activity. Loans, on the other hand, might offer tax advantages compared to selling, for the same reason that applies in the United States. However, interest earned on bitcoin loans may be considered taxable income in some EU countries.
Risks and considerations
Bitcoin-backed loans are not without risks. Bitcoin volatility is perhaps the most evident risk, with a sharp price decline potentially leading to margin calls and the potential partial or total liquidation of collateral. This factor requires careful monitoring of loan-to-value ratios and the ability to provide additional collateral or quickly repay the loan if the market becomes unfavorable.
Counterparty risk is another consideration when choosing a lending platform. The failures in 2022 of Celsius Network and BlockFi serve as reminders of the risks associated with entrusting assets to centralized lending platforms.
Regulatory uncertainty could represent another challenge. The regulatory landscape for digital asset lending is still developing, and changes to regulation could affect the tax aspects and operation of these services.
Finally, it’s important to consider the risks associated with rehypothecation, where custodial platforms might use bitcoin collateral for their own purposes, potentially increasing counterparty risk.
According to projections from HFT Market Intelligence, as of August 2024, the global bitcoin-backed loan market has reached a total value of approximately $8.5 billion. Analyses indicate growth in the sector, with forecasts estimating an expansion to about $45 billion by 2030.
Already during the PlanB Forum 2024 conference in Lugano, Max Keidun, CEO of Debifi, stated to Atlas21 microphones:
“Bitcoin is the perfect collateral. Its market is very liquid and you can sell the asset 24/7. I believe this is the best incentive there is. If you use real estate as collateral and the borrower can’t repay the loan, you’ll end up with a property you need to sell, a process that can take months or even years. Bitcoin can be sent to an exchange and sold quickly.”
